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Strategies & Market Trends : John Pitera's Market Laboratory
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To: OX who wrote (5463)1/26/2002 7:26:03 AM
From: Henry Volquardsen  Read Replies (2) of 33421
 
ABSOLUTELY!!!

this one has always been a pet peeve of mine. A normal yield curve with no expectations of interest rate moves one way or another is going to be positively sloped. It is going to reflect time premium. A slope of 25 to 50 basis points between 3 month and 1 year rates would reflect a neutral sentiment. If there is a similar slope between 1 and 2 year rates that would generate a front red ED as much as 100 bp+ higher than the front ED. And this is before taking into account convexity which will start to depress the reds by a few bp. So yes there was a closing differential of 217 bp point between March and red March but up to half of that would be expected in a neutral curve.

Also I have a philosophical disagreement with the notion that forward derivative prices, which is all the ED futures are, reflect market expectations. It was not that long ago that there was considerable academic debate about whether forward currency rates predicted market expectations of currency movements. To me the forward curve as a predictor of rate expectations is along the same line. Forward rates do not exist in and of themselves. They are merely derivatives that fall out of cash prices. There are rate expectations influences on cash but they are far from the sole determinant of curve relationships.

Fwiw history shows the forward curve is a poor predictor. The curve generally remains way to steep while the Fed is cutting as the market tends to lag the Fed. And once the Fed begins to tighten curves, at least initially, the curve is generally to shallow.
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